These days, investing is all the hype. But before you throw your money into the stock market, it’s important to understand the power of options trading. The good news is that you don’t have to be an expert to understand these strategies.
Once you understand the ins and outs of how options work, you can use these strategies to make wise investing decisions. Keep reading to learn about the five best options trading strategies for beginners.
There are all sorts of options trading strategies, ranging from simple to complex. But what all of these strategies have in common is that they’re based on two option types: calls and puts. A call option is when the holder has the right to buy a stock while a put is when the holder has the right to sell a stock.
If you have a good understanding of calls and puts, the next step is to understand some of the top options strategies. These five strategies are “one-legged,” which uses just one option in the trade.
Make note that simple doesn’t mean that these options trading strategies come without risk. Simple just means that they’re less complicated when compared to multi-legged options strategies.
The long call options trading strategy is when you buy a call option, also known as “going long.” This strategy takes a wager on the idea that the underlying stock will exceed the strike price by expiration.
Long call example: A1B2 stock trades at $30 a share. A call at $30 strike is available for $3 with a six-month expiration. The contract is for 100 shares, making the cost of the call $300 ($3 x 100 shares).
If a long call is well-timed, the benefits of this options strategy is infinite. You will profit as long as the stock moves higher, or until the expiration date. Even if the stock goes down, you can salvage some of the cost by selling before expiration.
The downside? A total loss of the premium.
The long call is a great way to earn much more profit on a stock, if you believe it will rise. You’ll make more profit on a long call than you would by owning the stock directly.
Like the long call, the long put is when you wager that a stock will decline versus increase.
With this options strategy, the investor buys a put option and bets that the stock will decrease to a value below the strike price by expiration.
Long put example: A1B2 stock trades at $30 a share, and a put at $30 a strike is available for $3 with a six-month expiration. The total put costs $300 ($3 x 100 shares). If by expiration the stock is worth $20, you’ll make $300. If it’s worth $10, you’ll make $900.
A long put is most valuable when a stock is at $0 per share. In the given example, the maximal value would be $3,000. Even if the stock increases, the put can be sold to save some of the premium.
The downside? A total loss of the premium.
A long put is a way to bet on a stock declining. If you’re willing to stomach the loss of the whole premium, this is a worthwhile options trading strategy. You’ll earn much more by owning puts than you would by short-selling a stock.
The short put is opposed of a long put. This options trading strategy is when an investor sells a put or “goes short.” This strategy counts on a stock staying flat or rising until the expiration. Like the long call, the short put does bet on a stock rising, but with notable differences.
Short put example: A1B2 stock trades at $30 a share. A put at $30 strike can be sold at $3 with a six-month expiration. The put is sold for $300 ($3 x 100 shares). The payoff of a single short put is the opposite of a long put.
When compared to a long call, a short put is a more modest gamble with a higher pay off. If a stock stays at or goes over the strike price, the seller gets the whole premium. If the stock stays below the strike price come expiration, the seller must buy the stock at the strike and realizes a loss.
The downside? If the stock drops to $0 a share. In this case, the short put would lose $3,000 ($3 x 100 x 100).
The short put is used by investors to generate income by selling the premium to others who at betting on the stock falling. However, investors shouldn’t make selling puts a routine occurrence. Otherwise, you’re on hook to buy shares if the stock drops below the strike at expiration.
Short puts are also a great way to achieve a better buy price on an overpriced stock. With this options trading strategy, puts can be sold at a much lower strike price.
The covered call is a two-part options trading strategy. First, the investor must own the underlying stock and then sell a call on it. In exchange for the premium, the investor gives away all appreciation over the strike price.
This strategy relies on the stock staying flat or dipping slightly until expiration. This allows the seller to keep the premium and the stock.
If the stock goes below the strike price at expiration, the call seller keeps the stock and can buy a new covered call. If the stock goes above the strike price, the investor must give all shares to the call buyer at the strike price.
For each 100 shares of stock, the investor sells just one call. Otherwise, the investor would be short “naked” calls. Covered calls turn naked calls into a more effective, and potentially safer option, especially for investors looking to turn a profit.
Cover call example: A1B2 stock trades at $30 a share. A call at a $30 strike can be sold for $3 with a six-month expiration. The call is sold for $300 ($3 x 100 shares). In this scenario, the investor already owns or buys 100 shares of A1B2.
The upside of a covered call is the premium if the stock remains at or a little below the strike price at expiration. If the stock price goes about the strike price, the call becomes more costly. This will offset most gains and cap the upside.
Because upside is capped, there’s a risk that sellers may lose a stock profit.
The downside is a total loss of the stock’s value, minus the premium. In this instance, the worst-case scenario would put the investor down $2,700.
The covered call is popular, especially for investors looking to make income with very little risk. This options trading strategy is also a great way to get a better sell price for a stock.
Like the covered call, the married put is a bit more sophisticated. It combines a long put as well as owning the underlying stock (aka “marrying” them). For each 100 shares of a stock, the investor buys a put. This enables the investor to keep owning the stock to profit from appreciation, while also being covered is the stock’s position falls.
The married put is like buying insurance. Investors pay a premium to protect against a decline in value of a stock.
Married put example: A1B2 stock sells at $300. A put at a $30 strike is available for $3 with a six-month expiration. Combined, the put costs $300 ($3 x 100 shares). The investor already owns 100 shares.
The biggest benefit of the married put is that the investors continue to own a stock that’s rising. This options trading steady also has a potentially infinite maximum gain. If the stock falls, the put generally matches any declines and offsets any loss.
The downside is the total loss of the premium, which in this instance would be $300.
The married put is used to protect gains from stock appreciation while wagering that more gains are to come.
Investing is more intricate and nuanced than most people think. Now that you know about the top five options trading strategies, there’s no better time to start making your money work for you!